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Argentina: maddeningly far from the crowd

While governments in most of the world have taken radical steps to battle the crisis, including buying stakes in banks, Argentina has gone much further by effectively nationalising its pension fund industry. At a stroke, the country has secured its ability to repay short-term debt; but at a very high price. Argentina has also slashed investor confidence in capital markets, worsened its already abysmal image for institutional predictability and imposed central control over how corporates raise capital. The shame is that the blow comes after several years of encouraging economic performance and moves to negotiate with bondholders.

That the new global order has arrived in an extreme and unorthodox way in Argentina is not so remarkable. The country has been subject to so many negative surprises that the country continues to provide plenty of material for economics textbook, particularly for its handling of the debt default of 2001.

Since the recession that followed the default and which lasted from 2000-02, the economy has recuperated well. It reported a whopping 11.7% GDP growth in 2003 after shrinking as much as 10.5% in 2001. Since then, GDP has topped 8% every year through 2007.

There has indeed been much good news, according to Walter Molano, head of research at BCP Securities in Greenwich, Conn. GDP growth should top 6% in 2008. International reserves are more than $47 billion, the primary surplus is 3.5% of GDP, and the current account surplus is 2% of GDP, he points out. Exports jumped 45% year-over-year this September, while imports rose 34% over the same period bringing the trade surplus for the first nine months of the year to $10.2 billion. Last of all, there is virtually no leverage within the Argentine consumer sector, he adds.

The country had also been making encouraging moves to do a deal with bondholders who held out from a 2005 agreement. Citigroup, Barclays Capital and Deutsche Bank have been running talks with hold-out bondholders on both the Argentine peso-denominated and the US dollar debt. Investors had seemed receptive to Argentinas plans. They were insisting that the renegotiation take place at same time as Paris Club debt and local liability were worked out, but the deal looked possible.

All this now looks in jeopardy. The global crisis dealt two blows to Argentina. The boost from the high commodities cycle that the country enjoyed has come to an abrupt end at the same time as a roughly 50% devaluation in Chile and Brazils currencies against the US dollar has wiped out Argentinas competitive advantage over its two neighbours.

The Pensions Fiasco

It was at this delicate stage and with debt and equity markets tumbling that the government rushed out the announcement that it was going to take over private pension funds. President Cristina Fernández announced her plan to nationalise the countrys 10 private pension funds on October 21. She argued that with volatility and speculation in financial markets, pensioners assets would be safer if run by the government and invested in safe instruments. Changes to the market are slated to begin in January 2009.

The bill went through the Senate on November 20 and has now passed both houses of Congress, with minor amendments. The funds will be transferred to social security agency ANSES, although AFJPs will be allowed to keep operating in the much smaller voluntary retirement savings business. Thats not much of a bone to be tossed as they amount to just 1% of AFJP funds today.

The make-up of ANSES and how it will run funds was unclear at press time. The Senate pushed through a measure that requires ANSES to invest assets profitably and safely and use a 13-member oversight board. It also limits the amount that can be loaned to the government through bond purchases. Analysts point out, though, that Argentina has a long track record of changing laws with little notice.

The National Bank or Ministry of Economy may be involved in running funds, according to Andrea Manavella, bank analyst at Moodys in Buenos Aires. Probably managers at the private pension funds will be brought over to supply expertise in running assets, she adds.

Already, the government has compelled pension funds to divest foreign investments. In the space of three days, Argentine pension funds were compelled to sell overseas holdings, just at a moment of great market weakness. The government insists it will keep investing in bond and equity markets, but Gabriel Torres, analyst at Moodys in New York, says that kind of directed lending means private sector enterprises, needing funding from government-run institutions, will restrain themselves from speaking out against public policies. In the past, the government has rewarded those that are close to it, he says.

Plans to nationalize the $26 billion private pensions fund industry caused the countrys investors to get the willies. US dollar-denominated par bonds traded down at 17 cents on the dollar, or below levels seen at the time of the 2005 renegotiation. The governments move, widely seen as an asset grab by foreign investors, added much fuel to concerns that the economy was turning down and government finances were suffering. It raised the spectre of a fresh debt default just seven years after the country stopped payments on $95 billion in debt.

Although investor sentiment has been negative, ironically, in the short-term the move provides the government with more flexibility. By bringing these assets under its control, the move will provide a boost to the countrys coffers and help pay down debt, analysts agree. Over a two to three year timeframe, the move is a net positive, reflects Torres. From a fiscal point of view they are getting money of 1% of GDP, he says.

The move was inevitable because there is an $8.5 billion gap between the debt that falls due next year ($19.93 billion) and the estimated amount available from the Treasury and other sources of financing, according to Martin Lousteau, ex-minister of the economy, who runs his own consultancy LCG.

Negative ramifications

While the short-term may provide some breathing room for Argentina, there are major longer-term negative consequences to the move, estimates Torres. The effect on capital markets, which have already been severely shrunk by the 2001-02 crisis, has already proved negative.

The Merval index fell 4.1% when the legislation passed the senate, bringing the index to a weekly decline of 19% and a year-to-date fall of 61%. On November 21, Argentinas 8.28% dollar bonds due 2033 were yielding some 28.52% up from 20.42% percent the day before the pension plan was announced.

This all comes on top of a much more difficult outlook for Argentine banks, which were growing on the back of easy conditions in international markets and appetite for securitized portfolios. Last year, many local banks were tapping international markets both to raise capital for lending and to better match short-term assets with long-term liabilities. This year that has not been possible, points out Manavella.

Those banks that were able to securitise portfolios had been able to increase lending substantially, according to Sergio Sarantini, head of product development at Banco Hipotecario. In 2007, each of the top five banks that was using the securitization market was lending on average $63 million per month against just over $17 million in 2000, he notes. Foreigners were particularly eager buyers of such instruments.

Banco Hipotecario itself issued peso-linked notes in international markets last year, raising US dollars and paying local currency and interest rate with the foreign exchange risk lying with the investor. These instruments were popular enough that the bank could place debt at tenors of more than five years at rates of less than 10%, points out Manavella.

Despite the closure of international markets and the corollary of a reduction in the diversity of funding sources for Argentine companies, there was still some borrowing choices for corporate and banks thanks to the array of competing pension funds. Nationalization does away with that competition and makes potential issuers dependent on one huge, state investor. Im afraid that this pension fund, and its policies, will determine liquidity for the entire market, says Ms Manavella. Car financing companies and smaller banks could be especially affected she believes.

The ripples will not be confined to large corporates looking to raise money. The capital markets were slowly developing instruments to stimulate credit to individuals and small- and medium-sized businesses. White goods were being sold through structured notes. The specialty stores that sold these goods can no longer finance themselves and have now cut credit to customers, Torres points out.

Thats particularly worrying as Argentina has lamentably low levels of credit, at just 15-16% of GDP, both significantly lower than the Latin American average and tiny compared to levels of 120-140% in the US. It has been a grossly underdeveloped market, but it was growing in importance, says Torres.

What will replace this market? Torres wonders. The government wants public banks to take on the role of credit providers, but it remains to be seen just how possible this will be as the severe credit crunch makes all banks hoarders of cash. That means the government is likely to step in and supply credit directly to companies and banks directly through its new pension funds.

Equally important is the impact on confidence in institutions where Argentina lags well behind all its neighbors, Chile, Argentina and even Brazil. Admittedly, Argentinas tattered reputation in this area is already so bad that this extra blow does not substantially alter perception of risk.

Theres a very weak institutional framework. You can debate the merits of [pension fund] nationalization and find reasons for and against. But the fact that there was no debate prior to nationalization leads to serious concerns about the future. The government can take-over whatever they want, says Torres.

The move is, unfortunately, not a total surprise for Argentina-watchers. That the Kirchners hatched up such an ill-conceived scheme late one night, without consulting anyone else, as a means to bolster market confidence should come as no surprise, says BCPs Molano.

An additional headache is that the government has now assumed the long-term liabilities of these pension funds. There are no actuarial predictions yet on the burden that will put on government finances. However, the reason that the government created private pension funds in the mid 1990s was that it felt it could no longer afford to be on the hook for the countrys entire pension fund system. Ironically, they have now once again assumed those liabilities.

Not only have the governments moves hurt capital markets, they have also exacerbated capital flight from the country. In last few quarters, capital flight has been heavy with resident and non-resident money leaving. Private deposits in Argentina feel seven billion pesos in October alone, according to Barclays. In a desperate bid to hold onto deposits, Argentine banks have more than doubled local deposit rates to 25.9% since mid-September

Until recently, the capital flight was compensated by money coming in to the current account balance. With commodity prices taking a bath and hurting the trade balance, reserve accumulation will become much harder.

The decision to nationalize the AFJPs effectively eliminates the last pool of investors from the markets. The last word lies with Molano. [The move] will destroy the domestic capital markets. With $30 billion in assets, the AFJPs were the main source of liquidity for the local equity, credit and bond markets. The pension funds were a source of financing for local retailers and corporate, he concludes.